One of the main components of investment management is an investment policy statement (IPS). It’s simple enough, yet often overlooked. The IPS serves as a strategic guide to the planning and implementation of an investment program.1
An IPS is a road map and reality check, yet many investors fail to establish one.
When properly utilized an IPS helps investors plan for a suitable asset allocation, investment selection and evaluation. It clearly defines roles and responsibilities and lays out directives for keeping investments aligned with a stated purpose.
A good IPS includes several key components, customized to each individual, family or institution. It specifically addresses issues of structure and governance, in addition to performance objectives and risk tolerance. Critical elements include time horizon, regulatory constraints, tax considerations, distribution requirements, potential funding liabilities and cash flow considerations, as well as investment restrictions, allowable asset classes and allocations.
Additionally, every IPS should define the parties involved and assign responsibility and accountability. The IPS can document the preferred means of communication between the investor and the advisor, reporting requirements, desired frequency of meetings/calls and the circumstances under which the portfolio should be rebalanced.
Well-defined investment objectives, allocation targets and risk tolerance criteria establish goals and form the basis for monitoring performance. Clearly articulated investment mandates, tax and cash flow considerations and rebalancing guidelines provide direction.
An often overlooked component is assignment of decision making responsibilities—whether they lie with the investor, advisor or individual managers. A related component is the monitoring of the IPS: Who should assume this responsibility and how frequently? What are the policy targets and the latitude within those targets?
Finally, the IPS should encourage a disciplined implementation of a sensible policy framework. For example, the IPS’s return objectives and allocation targets serve as a point of reference during unusually positive or negative market conditions, which may prompt rebalancing to long-term allocation goals. Return objectives and performance expectations should be clearly stated, quantifiable and realistic. Portfolio restrictions as they pertain to individual holdings and mission or impact investing should be distinctly defined.
While some of the elements of a good IPS are tangible, others are more subjective. For example, risk tolerance can vary greatly from investor to investor. When crafting an IPS, the client and the adviser can work together to define terms such as “risk tolerance,” “time horizon” and “liquidity needs.”
A well-crafted IPS establishes transparency between investor and advisor. The process of writing an IPS also gives investors greater understanding and control in the management of their assets. It affords them the opportunity to reach common ground with their advisors and creates a foundation for every decision.
The creation and upkeep—on a well-defined schedule—of an investment policy statement is particularly important in multi-generational family planning. A solid investment policy statement that is set forth by the founding generation and updated regularly in conjunction with future generations, helps ensure that the family legacy will continue as intended.
Overall, a carefully crafted IPS helps investors maintain focus on long-term policy targets during turbulent markets when such targets are most often in question.
1“Elements of an Investment Policy Statement for Individual Investors,” CFA Institute, 2010
All information contained herein is based on past performance and is not intended to be indicative of future results. There is no guarantee that historical risk and rate of return will persist in the future. The views and opinions expressed above are those of the portfolio management team at the time of writing and are subject to market, economic and other conditions that may change at any time; and, therefore, actual results may differ materially from those expected. This material does not constitute a recommendation to the suitability of any product or security and does not constitute an offer to buy or sell any financial instrument or to participate in any trading strategy. The analysis provided should not be relied upon as the sole factor in an investment decision. All investments contain associated inherent risks, including possible loss of principal.
This article was originally published in the February/March 2016 issue of Worth.